Financial Times Editorial - Bernanke revisits the bond conundrum
Bernanke revisits the bond conundrum
Published: March 22 2006 02:00 | Last updated: March 22 2006 02:00. Copyright by the Financial Times
One of the hardest tasks of a central banker is to discuss new trends that might affect monetary policy without roiling the markets. This acclimatises opinion to any future changes in the direction of interest rates and minimises the risk of abrupt market corrections. Ben Bernanke, the new chairman of the US Federal Reserve, is known to put a high value on such communication. Yet at this stage of the interest rate cycle it is hard to give clear guidance, particularly in the light of what his predecessor, Alan Greenspan, famously called the "conundrum" of low long-term interest rates.
As Mr Bernanke explained on Monday, the forces governing long-term interest rate behaviour are "not at all clear cut". By extension, neither are the implications for monetary policy. Mr Bernanke is unlikely to cause surprise next week at his first Federal Open Market Committee, which is expected to add a quarter point to the benchmark rate. This would be the Fed's 15th consecutive rise, adding 3.75 percentage points since the start of monetary tightening in 2004 when the rate was just 1 per cent. But the subsequent path of rates remains uncertain, in part because the significance of low long-term rates remains so unclear.
One view is that long-term rates have declined because investors require a lower risk premium to hold longer-term debt. This might reflect a reduction in global economic volatility. Added to this, there is arguably an excess of demand for US Treasuries over supply. Market participants may be anticipating increased demand for long-dated fixed income securities as the baby boom generation retires. There has also been high demand for US Treasuries by foreign central banks. This analysis suggests that the decline in long-term rates is broadly stimulative. If correct, it suggests that the Fed should raise its policy rate higher than it would have done if long-term rates were not unusually low.
The contrasting view - originally popularised by Mr Bernanke himself - says a "global savings glut" has pushed down long-term interest rates around the world. The notion of a structural decline in interest rates reassures those who would normally interpret a flat or inverted yield curve as a harbinger of recession. Still, a global savings glut would imply that the neutral policy rate would be lower than it might otherwise be. If this analysis is right, it reinforces the case for the Fed to end its tightening cycle soon, possibly next week or in May. However, growth in Europe and Japan may reduce any savings glut and other factors clearly have to be taken into consideration, too.
These contrasting views present the Fed itself with a conundrum. In such circumstances central bankers can only share their musings, be honest about the limits of their knowledge and await data that will help lift the fog. By that yardstick Mr Bernanke is proceeding as he should.
Published: March 22 2006 02:00 | Last updated: March 22 2006 02:00. Copyright by the Financial Times
One of the hardest tasks of a central banker is to discuss new trends that might affect monetary policy without roiling the markets. This acclimatises opinion to any future changes in the direction of interest rates and minimises the risk of abrupt market corrections. Ben Bernanke, the new chairman of the US Federal Reserve, is known to put a high value on such communication. Yet at this stage of the interest rate cycle it is hard to give clear guidance, particularly in the light of what his predecessor, Alan Greenspan, famously called the "conundrum" of low long-term interest rates.
As Mr Bernanke explained on Monday, the forces governing long-term interest rate behaviour are "not at all clear cut". By extension, neither are the implications for monetary policy. Mr Bernanke is unlikely to cause surprise next week at his first Federal Open Market Committee, which is expected to add a quarter point to the benchmark rate. This would be the Fed's 15th consecutive rise, adding 3.75 percentage points since the start of monetary tightening in 2004 when the rate was just 1 per cent. But the subsequent path of rates remains uncertain, in part because the significance of low long-term rates remains so unclear.
One view is that long-term rates have declined because investors require a lower risk premium to hold longer-term debt. This might reflect a reduction in global economic volatility. Added to this, there is arguably an excess of demand for US Treasuries over supply. Market participants may be anticipating increased demand for long-dated fixed income securities as the baby boom generation retires. There has also been high demand for US Treasuries by foreign central banks. This analysis suggests that the decline in long-term rates is broadly stimulative. If correct, it suggests that the Fed should raise its policy rate higher than it would have done if long-term rates were not unusually low.
The contrasting view - originally popularised by Mr Bernanke himself - says a "global savings glut" has pushed down long-term interest rates around the world. The notion of a structural decline in interest rates reassures those who would normally interpret a flat or inverted yield curve as a harbinger of recession. Still, a global savings glut would imply that the neutral policy rate would be lower than it might otherwise be. If this analysis is right, it reinforces the case for the Fed to end its tightening cycle soon, possibly next week or in May. However, growth in Europe and Japan may reduce any savings glut and other factors clearly have to be taken into consideration, too.
These contrasting views present the Fed itself with a conundrum. In such circumstances central bankers can only share their musings, be honest about the limits of their knowledge and await data that will help lift the fog. By that yardstick Mr Bernanke is proceeding as he should.
posted by Carlos T Mock at 12:22 PM
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